Effective EBA Pillar 2 split offers AT1 relief

The European Banking Authority (EBA) offered relief to the Additional Tier 1 (AT1) market on 1 July when it announced that stress test-related Pillar 2 requirements need not be included in MDA calculations, thereby easing fears of coupon payment restrictions that had plagued the sector.

In an information update on the 2016 EU-wide stress tests — the results of which are due on 29 July — the regulator effectively said that it would split out from Pillar 2 “Capital Guidance” it deems necessary to cover potential shortfalls in own funds based on the outcomes of the stress tests.

The move breaks from the EBA’s previous stance of Pillar 2 wholly being included in maximum distributable amount (MDA) calculations — a surprise position announced in December that wrought havoc upon the AT1 market in the first quarter, as market participants had to try to reassess upwards the likelihood of coupons not being distributed.

A relaxation of the moves had been anticipated after pressure from various quarters including the European Parliament, and European Central Bank and EBA representatives had in recent months flagged a likely change. Danièle Nouy (pictured, right), chair of the supervisory board of the SSM at the ECB, for example, said on 8 June that Pillar 2 would be split into binding and non-binding guidance, with only the binding element relevant to MDA.

In its update, the EBA said that the quantitative results of the stress test should be used by Competent Authorities to assess whether a bank will be in a position to meet its Total SREP Capital Requirement (TSCR) under all scenarios (i.e. also the most severe scenarios) and what would be the impact on the Overall Capital Requirement (OCR). In EBA terminology, the TSCR refers to the sum of Pillar 1 and Pillar 2 capital requirements, and the OCR to TSCR plus the applicable Combined Buffer Requirement (CBR — the sum of the Capital Conservation Buffer, systemic buffers, countercyclical buffers, etc).

The EBA then clarified what Competent Authorities may undertake in the event of a breach of the TSCR under the stress test. If there is no danger of imminent TSCR breach, then the Competent Authorities should perform additional analysis as per paragraph 366 of the EBA SREP Guidelines.

Following this analysis the EBA details two specific measures the Competent Authorities could consider:

Potential restrictions on dividend payments to shareholders; and/or

The setting of additional Capital Guidance, positioned above the CBR.

According to Doncho Donchev, capital solutions, debt capital markets, Crédit Agricole CIB, of critical importance are the EBA’s clarification that (i) the Capital Guidance sits above the CBR and (ii) the Capital Guidance is not included in the calculations of the MDA, i.e. a breach of the Capital Guidance does not lead automatically to distribution restrictions, including the payment of coupons on AT1.

He said that the EBA is effectively introducing into the EU framework a split between Pillar 2 into Pillar 2A and 2B —akin to that used by the UK Prudential Regulation Authority (PRA), where Pillar 2B (equivalent to the Capital Guidance) is dubbed the PRA buffer.

“Provided the ECB/SSM applies the EBA statements in this update, then the Pillar 2 included for SSM banks supervised by the ECB should be reduced and thus the threshold for restrictions which apply to AT1 coupon payments should be lowered by the amount of the stress test-related component currently included in Pillar 2,” said Donchev.

He said that this should provide welcome relief to the sector.

“After the surprise SREP decisions which led to the sell-off — the violence of which obviously surprised even the regulators — they have sought to calm the market and make structural improvements,” said Donchev. “So, following the informal announcements from Danièle Nouy and Sabine Lautenschläger, now we have the first regulatory announcement in writing, which obviously provides a further brick on the road to regulatory repair.”

He noted that if the stress tests reveals the danger of an imminent TSCR breach, Competent Authorities nevertheless have the flexibility to include the Capital Guidance in the Pillar 2 requirement, i.e. Pillar 2B is added to Pillar 2A and repositioned below the CBR.

The results of the stress tests must be factored into the 2016 SREP, applicable from 2017.